Friday, October 31, 2008


I have no special affinity for "oil companies" but discussion of their profits are interesting, especially around the time that they announce earnings, at least when they break profit records in absolute terms.

But the "absolute terms" is what is interesting actually. The headlines breathlessly exclaim how Exxon sets record profits. Yesterday it was $14.8B. What they don't put in the headline, and sometimes not even in the story body, is the revenue number - which in this case was $137.7B. This gives them a 10.7% profit margin. Not so exciting actually.

Today Chevron announced similar results in margin - profit of $7.89B on $76.2B, or a similar-to-Exxon 10.4% profit margin.

Also today, but without much associated consumer uproar, Clorox (maker of the bleach, as well as things like salad dressing and trash bags) announced $128mm profit on $1.38B, for 9.3%. Not as big as "big oil" but interesting for comparison.

Why does this interest me? Mostly because considering only *absolute* profit and not profit *margin* distorts the economic view of what is going on. People especially feel that they are being gouged on prices if they just hear that the oil companies "are making record profits". What if the headline was "Exxon once again makes about as much relative profit as other companies"?

Why does it matter? In my opinion it matters because it can lead to very bad public policy.

Talk of a "windfall profits" tax on oil companies is based on feeding off the anger people feel about how much the oil companies make. The idea has legs because generally people feel ripped off by the oil companies and feel they receive an "unfair" profit. I believe a lot of this feeling is based on considering the absolute profit over the profit margin.

I personally think any windfall profits tax is an extremely bad idea, not just pragmatically, but in a way ethically. The idea here is to tax a company (or companies) simply for being profitable and having invested their energy in an area of enterprise that was a good investment. It puts government in the role of deciding how much profit is "too much" profit. If "big oil" has special tax breaks or such that people want removed that is one thing, but I think structuring something as a windfall profits tax is wrong. Ethically it changes the rules of the game in the middle. Pragmatically it would act to stifle investment in the area in question - in this case the energy sector, which for a healthy economy is not an area you want struggling.

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